Valuations show China stocks to stabilize

But the fall has brought valuations to a more reasonable level based on China's economic fundamentals, particularly corporate earnings prospects, and should give the main index strong support around the psychological 5,000-point level, local fund managers and analysts said.

The benchmark Shanghai Composite Index bounced above 5,000 points late on Friday, after breaching that mark for the first time in three months the previous session, when it tumbled more than 4 percent.

The market is down 18 percent from a record intraday high of 6,124 points on October 16, but still up 88 percent year-to-date.

The fall is about over, said Yan Zhenghua, chief strategist at China Asset Management Co in Beijing. Unless a major slowdown in China's economy suddenly appears, we don't see the logic for the market to fall further.

The plunge has been partly propelled by international brokerages' repeated warnings of a bubble.

Morgan Stanley said this week that China's A-share market, accessible almost only by local investors, was struggling to stay at its current high valuations. It said any further negative news could speed up a correction to levels that might resemble what happened in Japan in the late 1980s, where markets nearly halved inside a year.

The A-share market hosts not only the biggest valuation bubble among world equities, but also one of the largest earnings bubbles, Morgan Stanley said in a research report.

PRICES JUSTIFIED

But local fund managers and analysts said the latest fall had lowered the average price-to-earnings (PE) ratio of 300 large-cap companies listed in Shanghai and Shenzhen to 33 times 2007 forecast earnings and 28 times 2008 earnings.

While other major international markets trade on PEs of 12-18 times, China's powerful growth justifies a premium, they argue.

Such valuations at most imply a small bubble, if the word bubble can even be used to describe the market, said Cao Xuefeng, senior stock analyst at West China Securities in Chengdu.

Imagine how many big global economies have seen economic growth of 10 percent or more since 2002 like China? And there are no signs that China's economy will fall below that level next year. The risk is on the upside instead of the downside.

A concern of some global investment bankers has been the role of stock market returns in corporate earnings during the first three quarters of this year, which some estimated as high as 30 percent of total net profits.

REAL EARNINGS

But local analysts insist the bulk of the earnings are real, buoyed by economic growth and improved management in the corporate sector due to reforms over the past three decades.

A research report by the prestigious China Academy of Social Sciences issued on Thursday said China's major industrial firms have seen a sustained average profit jump of 37.6 percent each year from 1998 to 2006, propelled mainly by the improvement of the benchmark return on assets (ROA).

China's industrial enterprises have gradually transformed into a period of high profitability, Jin Bei, editor-in-chief of the Report on Chinese Corporate Competitiveness, was quoted as saying by the official Shanghai Securities News on Friday.

With the economy showing no signs of a major downturn, analysts said corporate earnings growth in the next 3-5 years should not be much lower than in the 1998-2006 period.

Eight local securities house analysts surveyed by Reuters on Thursday and Friday said they were maintaining their forecasts of roughly 30 percent profit growth next year, still brisk, although slower than this year's estimated 50-60 percent.

Several factors besides a booming economy will drive earnings growth.

Yuan appreciation against the dollar is showing signs of accelerating, which will raise asset values.

Authorities are saying they aim to step up injections of assets by state enterprises into their listed subsidiaries, which has provided a big boost for corporate earnings this year.

Building a strong stock market is also a major policy goal for China. Regulators are pushing large-capitalized, profitable firms to list on the market.

China is set to unify domestic and foreign companies' corporate income tax next year, bringing down the duty level for local corporations to 25 percent from 33 percent, analysts said.

A survey published on Friday in the official China Securities Journal showed that 83 percent of fund managers said China was still in the middle of a bull market, while 40 percent forecast that the index would hit a record 8,000 points next year.

($1=7.40 Yuan)

(Editing by Edmund Klamann & Lincoln Feast)